Deribit moved to block users in Japan after the country tightened its crypto rules. Other derivatives exchanges are weighing their options

Japan is one of the few countries to have clear regulations for cryptocurrency activities.

Back in 2017, Japan passed rules that mandated crypto exchanges to be licensed in the country. The regulations around crypto businesses came about after the collapse of Mt Gox, which captured worldwide regulator attention and triggered rule-making efforts in other countries, including the United States. 

Last year, Japan revised its Payment Services Act (PSA) and the Financial Instruments and Exchange Act (FIEA) to strengthen further its crypto rules, which came into effect from May 1, 2020.

The revised crypto rules are more stringent, which led crypto derivatives exchange BitMEX to stop serving residents of Japan.

Now, another major crypto derivatives exchange – Deribit – has decided to pull back in light of these rules, The Block has learned. "Since the 1st of May we stopped serving Japanese residents," Marius Jansen, co-founder and COO of Deribit, told The Block.

Per the amended regulations, a crypto derivative exchange is now required to be registered in Japan as a "Type I Financial Instruments Business" under the country's FIEA. This means that these exchanges will be subject to similar capital adequacy and collateral requirements as currency or interest rate derivatives exchanges, Katsuhiko Fujihira, senior of counsel at Japanese law firm Morrison & Foerster, told The Block.

Those exchanges which will find it difficult to meet these requirements "may need to withdraw from derivatives business," said Fujihira.

Another significant change for crypto derivatives exchanges is that they can't offer more than two times leverage to retail investors beginning on April 30, 2021.

"Since the new regulations introduced maximum leverage of 2x for retail investors, BitMEX withdrew from the Japanese market for now as they offer much higher leverage," So Saito, partner at Japanese law firm So & Sato, told The Block.

BitMEX and Deribit both offer up to 100x leverage, and this, perhaps, explains why both the exchanges have stopped serving in Japan.

However, since the revised rules were known to be put in place from last year itself, exchanges "have had ample time to decide whether or not to remain in Japan," said Elsa Madrolle, international GM at crypto compliance solutions firm CoolBitX. "BitMEX likely based its commercial decision taking into consideration the types of clients they expect to attract."

Weighing the options

Other crypto derivative exchanges OKEx and FTX are still weighing their options as to whether they want to continue serving residents of Japan.

"We are aware of the new requirements...Currently, OKEx is preparing a strategy internally to ensure compliance with the new regulatory requirements in Japan to the extent it applies," an OKEx spokesperson told The Block.

FTX CEO Sam Bankman-Fried also shared a similar response: "We're investigating what the best approach to Japan is and consulting with counsel."

It's worth noting that crypto derivatives account for around 90% of the total crypto trading volume in Japan.

Other top global crypto exchanges, Gemini, Kraken and Coinbase, are not operational in Japan, their spokespersons told The Block. Notably, Coinbase has been looking to enter the Japanese market since 2018 but has yet to receive a license.

Binance declined to comment when reached, but earlier this year, the exchange announced that it would implement a "gradual restriction of trading functions" for Japanese residents "at a later date."

Bitfinex did not respond to requests for comments. The exchange's website does not show Japan under the list of prohibited jurisdictions.

Local players

Some crypto exchanges that are already registered in Japan are looking to comply with revised regulations.

Tokyo-based bitFlyer, for instance, told The Block: "We continue to offer our Crypto Asset derivatives services to our customers who have completed KYC. Regarding our derivatives trades for individuals, we will change our leverage from four times to two times by 2021 on 30th April."

"As of today, we are a 'deemed business operator', but we plan to register ourselves as a 'Type 1 Financial Instruments Business Operator,'" to comply with amended regulation, bitFlyer added. The exchange also believes that revised rules have made crypto exchanges in Japan "much safer and more secure for customers."

Another local exchange, BITMAX – operated by Japan's messaging giant LINE – told The Block: "We constantly ensure that our policies and controls comply with all local regulations and it is no different this time."

A Huobi Japan spokesperson told The Block that the exchange "holds the 00007 license issued by [Japan’s Financial Services Agency]. We operate our businesses by fully embracing the regulation and following all compliances. We pay close attention to the rules and changes made by FSA." The firm did not provide specific details.

OKCoin Japan, which recently got registered in the country, and SBI VC Trade exchange, declined to comment on how they plan to comply with amended crypto regulations.

Tougher crypto custody rules

Another significant amendment to Japan's rules focuses on firms that provide custody of cryptocurrencies. "Crypto custodians (e.g. wallet service providers controlling a user's private keys) must register as crypto asset exchanges in Japan," Saito told The Block.

Further, the amended rules require exchanges to store at least 95% of their users' crypto assets in cold or offline wallets, while up to 5% may be held in "hot" or online wallets.

"If an exchange stores some of its users' crypto assets in a hot wallet, it has to store the same amount of its own crypto assets in a cold wallet. For instance, if an exchange stores 1 bitcoin of its users' assets in a hot wallet, it must store 1 bitcoin from its own assets in a cold wallet," explained Saito. 

Exchanges, therefore, may need to raise additional capital to maintain a segregated pool of crypto assets corresponding to customers' funds held in a hot wallet, according to lawyer Fujihira.

"We may also see new insurance products" due to this aspect of custody rules, said CoolBitX's Madrolle.

Will 'limit new entrants'

While Japan’s amended rules are aimed at protecting customers, it will "naturally limit new entrants," according to Madrolle.

Nonetheless, these rules are also designed to "encourage fair market practices," and should be seen as a "significant" step towards the mainstream acceptance of crypto assets in Japan, said Madrolle.

Then again, according to Saito, "it is now difficult for startups to do business" in Japan, given the stricter regulations.

Related reading:
https://innovationlaw.jp/en/digital-assets-in-japan/
https://www.mofo.com/resources/insights/200423-japanese-cryptocurrency-update.html